Amortization of Bond Premium Step by Step Calculation with Examples
For 20X4, interest expense is roughly 6.1% ($6,294 expense divided by beginning of year liability of $103,412). Thus, Schultz will repay $31,470 more than was borrowed ($140,000 – $108,530). The present value factors are taken from the present value tables (annuity and lump-sum, respectively). Take time to verify the factors by reference to the appropriate tables, spreadsheet, or calculator routine.
What does it mean to amortize a bond premium?
An amortizable bond premium refers to the excess amount paid for a bond over its face value or par value. Over time, the amount of premium is amortized until the bond reaches its maturity.
Usually, an organization uses a straight-line method to amortize this premium payment over the bond period. Due to legislative delays contributing to the state of trade, bonds trade at a discount or premium to par rate. Originating long-term bonds describe an important origin of investing or funding for any organization. When an organization plans to provide how to calculate premium on bonds payable bonds to an investor, they calculate the coupon rate that is agreeable. This affects both the current rate of interest and the wealth of an organization. It takes a significant amount of time to apply the process of issuing bonds to the public. One simple way to understand bonds issued at a premium is to view the accounting relative to counting money!
Calculation of bond premium
First, it must record any final interest payments that are made. This is done by debiting the bond payable account and crediting the cash account for the full book value of the bond. When a business issues a bond, it participates in three types of transactions. Next, it generally pays interest during the term of the bond. Finally, it pays off the obligation by repaying the face amount and the last interest payment.
- The investors will lend the money to the bond issuer by buying the bond.
- But the bond premium has to be amortized for each period, and a reduction of cost basis in the bond is necessary each year.
- Governments, corporations and other entities sometimes issue bonds to raise money for capital projects or public activities.
- As a result, interest expense each year is not exactly equal to the effective rate of interest (6%) that was implicit in the pricing of the bonds.
Calculate the total amount of interest you’ll receive if you hold the bond until maturity. You can do that by multiplying the interest payments times the number of payments left.
What Is the Carrying Value of a Bond?
The bond’s term is used as the time period in the present value calculation. When the company makes an interest payment, it must credit, or decrease, its cash balance by the amount it paid in interest.
- Such discounts occur when the interest rate stated on a bond is below the market rate of interest and the investors consequently earn a higher effective interest rate than the stated interest rate.
- When a bond is sold at a premium, the difference between the sales price and face value of the bond must be amortized over the bond’s term.
- The issuing company will still be required to pay the bondholder the interest payments guaranteed by the bond.
- This occurs when a bond’s coupon rate surpasses its prevailing market rate of interest.
- On July 1, Lighting Process, Inc. issues $10,000 ten‐year bonds, with a coupon rate of interest of 12% and semiannual interest payments payable on June 30 and December 31, when the market interest rate is 10%.
If a corporation issues only annual financial statements and its accounting year ends on December 31, the amortization of the bond premium can be recorded once each year. In the case of the 9% $100,000 bond issued for $104,100 and maturing in 5 years, the annual straight-line amortization of the bond premium will be $820 ($4,100 divided by 5 years). To illustrate the premium on bonds payable, let’s assume that in early December 2020, a corporation has prepared a $100,000 bond with a stated interest rate of 9% per annum (9% per year). The bond is dated as of January 1, 2021 and has a maturity date of December 31, 2025. The bond’s interest payment dates are June 30 and December 31 of each year. This means that the corporation will be required to make semiannual interest payments of $4,500 ($100,000 x 9% x 6/12). When the bond is sold, the company credits the « bonds payable » liability account by the bonds’ face value.
The present value factors are multiplied by the payment amounts, and the sum of the present value of the components would equal the price of the bond under each of the three scenarios. Calculating Bond Premium amortized can be done by any of the two methods mentioned above, depending on the type of bond. However, the difference arises in the pace of interest expenses. For the remaining 7 periods, we can use the same structure presented above to calculate the amortizable bond premium. It can be seen from the above example that a bond purchased at a premium has a negative accrual, or in other words, the basis of the bond amortizes.
- The initial book value is equal to the bond premium balance of $41,000 plus the bond’s payable amount of $1 million.
- Over the life of the bonds, the $150,000 premium is to be accounted for as a reduction of the corporation’s interest expense.
- The calculations are similar to those used in the discount example in Accounting for Bonds Issued at a Discount.
- To balance this entry, the company must also debit cash equal to the face value of all the bonds issued.
Essentially, the carrying value represents the money owed to bondholders. If the Premium is known, the Payments or the Yield may be calculated when the other data is known Simply leave the unknown field blank.
How to Calculate Interest Receivable From a Bond Amortization
When the central banks, such as the Federal Reserve and the Bank of England, change their interest rate policies, the bond prices fluctuate. Specifically, the bond price increases when the interest rates go down and vice versa. It is important when completing the zero-coupon bond calculation to ensure the time period and term of the bond are expressed in similar terms. If the interest rate of the bond is expressed as a monthly rate and the term of the bond is 10 years, the bond term should be expressed as 120 months when making the calculation. The value of a zero-coupon bond equals the present value of its face value discounted by the bond’s contract rate. When calculating the present value of a bond, use the market rate as the discount rate. From the given data, the premium bond amortization value is $291,600.
Think of bonds as financial securities that are separate from its respective premium or discount amount. Premiums and discounts will be stated as separate line items on the company balance sheet and will be amortized by using the effective interest method , and at times, the straight-line method). Let’s modify our example so that the prevailing market rate is 10 percent and the bond’s sale proceeds are $961,500, which you debit to cash at issuance. At the time of issuance, the firm receives proceeds from issuing the bond. A bond payable is valued at the present value of its future cash flows . These cash flows are discounted at the market rate of interest at issuance.
The premium of $7,722 represents the present value of the $1,000 difference that the bondholders will receive in each of the next 10 interest periods. For each month that the bond is outstanding, the “Interest Expense” is debited, and “Interest Payable” will be credited until the interest payment date comes around, e.g. every six months.